B1-1 Flashcards
The Sarbanes-Oxley Act of 2002 requires that the officers of a corporation be held accountable to a code of ethics. According to the Act, codifications of ethical standards should include provisions for all of the following, except:
a.
Prompt internal reporting of code provisions and accountability for adherence to the code.
b.
Compliance with laws, rules and regulations.
c.
Full, fair, accurate, and timely disclosure in periodic financial statements.
d.
Honest and ethical conduct.
Choice “a” is correct. Although the SEC proposed standards for codes of ethics to include both internal reporting of code provisions and accountability for adherence to the code, the Sarbanes-Oxley Act itself does not have this requirement.
Choice “d” is incorrect. The Act specifically requires that the code of ethics include provisions for honest and ethical conduct.
Choice “c” is incorrect. The Act specifically requires that the code of ethics include provisions for full, fair, accurate, and timely disclosure in periodic financial statements.
Choice “b” is incorrect. The Act specifically requires that the code of ethics include provisions for compliance with laws, rules, and regulations.
The Enterprise Risk Management-Integrated Framework of the committee of sponsoring organizations (COSO) is best defined as a:
a.
Process that replaces the COSO internal control framework.
b.
Process that takes a control-based approach to an organization.
c.
Process effected by an entity’s board of directors, management, and other personnel.
d.
Serial process in which one component affects only the next component.
Choice “c” is correct. It is actually stated in the definition provided by COSO for enterprise risk management (ERM) that it is “a process, effected by an entity’s board of directors, management, and other personnel.”
Choice “d” is incorrect. ERM is comprehensive, in that one component affects many other components of an organization.
Choice “b” is incorrect. ERM takes a risk-based approach to an organization.
Choice “a” is incorrect. The COSO internal control framework assists organizations in developing assessments for internal control effectiveness. This is separate from enterprise risk management, which is used for developing a response to risk management.
Knox, president of Quick Corp., contracted with Tine Office Supplies, Inc. to supply Quick’s stationery on customary terms and at a cost less than that charged by any other supplier. Knox later informed Quick’s board of directors that Knox was a majority stockholder in Tine. Quick’s contract with Tine is:
a.
Void because the disclosure was made after execution of the contract.
b.
Valid because the contract is fair to Quick.
c.
Void because of Knox’s self-dealing.
d.
Valid because of Knox’s full disclosure.
Choice “b” is correct. If a corporation enters into a contract and a director has a conflict of interest in the transaction, the contract is voidable unless the director makes full disclosure of all of the facts to the disinterested directors or the shareholders, who then approve the transaction, or the director can prove that the transaction was fair to the corporation. The stationery purchase was fair to Quick, since it was purchased at a below-market price. Thus, the contract is valid.
Choice “c” is incorrect. A director’s self-dealing does not automatically make a contract void. The contract can be upheld if it was fair.
Choice “a” is incorrect. A director’s self-dealing does not automatically make a contract void. The contract can be upheld if it was fair.
Choice “d” is incorrect. If a corporation enters into a contract and a director has a conflict of interest in the transaction, the contract is voidable unless the director makes full disclosure of all of the facts to the disinterested directors or shareholders, who then approve the transaction, or the director can prove that the transaction was fair. Mere disclosure after the contract was adopted does not automatically render the contract valid.
The external auditors for the Horace Company assess the achievement of internal control objectives each year and communicate the assessment to management and the Board. Communication by the external auditor illustrates which principle of the information and communication component of the Committee on Sponsoring Organization’s Integrated Framework?
a.
Internal Control Information.
b.
Financial Reporting Information.
c.
Internal Communication.
d.
External Communication.
Choice “d” is correct. The principle of external communications asserts that matters affecting the achievement of financial reporting should be communicated with outside parties.
Choice “b” is incorrect. The principle of financial reporting information principles conveys the idea that information should be identified, captured, used at all levels of the company, and distributed in a manner that supports achievement of financial reporting objectives.
Choice “a” is incorrect. Internal control information is needed to facilitate the function of control components and is identified, captured, used, and distributed in a timely manner that enables personnel to fulfill their responsibilities.
Choice “c” is incorrect. The principle of internal communications asserts that communications should enable and support understanding and execution of internal control objectives, processes and individual responsibilities.
Establishing objectives that will support the mission and vision of an organization generally involve supporting the mission with:
a.
Related objectives.
b.
Strategic objectives, supported by strategies and related objectives.
c.
Strategy supported by strategic and related objectives.
d.
Strategy.
Choice “b” is correct. Strategic objectives support the mission and are implemented via various strategies and related objectives.
Choice “c” is incorrect. Strategic objectives are implemented by strategy and supported by related objectives.
Choice “d” is incorrect. Strategy requires related objectives to be fully implemented.
Choice “a” is incorrect. Related objectives support various strategic plans that support the mission.
The Justco Corporation completed its annual retreat of board members and senior management and produced a document that links the organization’s mission and vision with strategic and related objectives. The document includes a commitment to conduct focus groups with customers and suppliers to determine the responsiveness of Justco to the needs of various parties. That commitment would most likely be a:
a.
Related compliance objective.
b.
Strategic objective.
c.
Related operations objective.
d.
Related reporting objective.
Choice “c” is correct. Conducting focus groups would most likely be a related operating objective. Focus groups would identify the needs of various stakeholders and be used to improve operations.
Choice “b” is incorrect. Strategic objectives are generally less operationally specific than the related objective contemplated by conducting focus groups.
Choice “d” is incorrect. Conducting focus groups is a related operations objective, not a reporting objective.
Choice “a” is incorrect. Conducting focus groups is a related operations objective, not a compliance objective.
The principle that protects corporate directors from personal liability for acts performed in good faith on behalf of the corporation is known as:
a.
The responsible person doctrine.
b.
The business judgment rule.
c.
The clean hands doctrine.
d.
The full disclosure rule.
Choice “b” is correct. If a director acts in good faith and in a manner the director believes is in the best interest of the corporation, and the director exercises the care that a reasonably prudent person would exercise in a similar position, the director is protected against liability for decisions the director makes that turn out poorly for the corporation. This is commonly known as the business judgment rule.
Choice “c” is incorrect. The clean hands doctrine (better known as the unclean hands doctrine) is a defense in actions brought in cases seeking equitable relief (e.g., an action seeking specific performance of a contract). If a person seeking equitable relief has acted improperly in the transaction before the court, he is said to have unclean hands and the court will not grant equitable relief. The doctrine has nothing to do with releasing directors from liability for acting in good faith and is outside the scope of the CPA Exam topics.
Choices “d” and “a” are incorrect. There are no such rules. Full disclosure may be required in certain situations under corporate law, but such disclosure requirement is not the described doctrine.
According to COSO, which of the following is a compliance objective?
a.
To maintain accounting principles that conform to GAAP.
b.
To maintain adequate staffing to keep overtime expense within budget.
c.
To maintain a safe level of carbon dioxide emissions during production.
d.
To maintain material price variances within published guidelines.
Choice “c” is correct. Maintaining safe (mandated by regulation) carbon dioxide emissions during production is a compliance objective. Compliance objectives include adherence to the laws, rules, and regulations associated with operations, including environmental regulations and other laws.
Choice “b” is incorrect. Maintaining adequate staffing to keep overtime expense within budget is likely an operations rather than compliance objective.
Choice “d” is incorrect. Maintaining material price variances within published guidelines is likely an operations objective.
Choice “a” is incorrect. Maintaining accounting principles that conform to GAAP is likely a reporting objective.
A company that retains a CPA with the appropriate knowledge, skills and abilities to prepare timely and effective financial reporting is applying the ideas from which principle of effective internal control over financial reporting?
a.
Accountability.
b.
Management philosophy and operating style.
c.
Integrity and ethical values.
d.
Financial reporting competencies.
Choice “d” is correct. The financial reporting competencies principle of the control environment component of internal control integrated framework suggests stronger controls and encourages the company to retain qualified personnel to handle financial reporting.
Choice “c” is incorrect. The integrity and ethical values principle of the control environment component of internal control integrated framework suggests stronger controls with high standards of ethical conduct for top management, but does not address retention of qualified personnel to handle financial reporting.
Choice “b” is incorrect. The management philosophy and operating style principle of the control environment component of internal control integrated framework suggests strong controls and encourages management’s attitudes to be congruent with strong financial controls, but does not address retention of qualified personnel to handle financial reporting.
Choice “a” is incorrect. The accountability principle of the control environment component of internal control integrated framework suggests strong controls and encourages management to hold individuals accountable for their internal control responsibilities, but does not address retention of qualified personnel to handle financial reporting.
Which of the following is necessary to be an audit committee financial expert according to the criteria specified in the Sarbanes-Oxley Act of 2002?
a.
Education and experience as a certified financial planner.
b.
Experience with internal accounting controls.
c.
Experience in the preparation of tax returns.
d.
A limited understanding of generally accepted auditing standards.
Choice “b” is correct. The financial expert serving on the audit committee of an issuer must have experience with internal controls. The financial expert qualifies through education or past experience as an auditor or finance officer for an issuer of similar complexity.
Choice “d” is incorrect. The financial expert qualifies through education or past experience as an auditor or finance officer for an issuer of similar complexity. The expert should have an understanding of GAAP, application of GAAP, an understanding of internal controls and an understanding of audit committee functions. There is no requirement to have a limited understanding of GAAS.
Choice “a” is incorrect. The financial expert qualifies through education or past experience as an auditor or finance officer for an issuer of similar complexity. The expert should have an understanding of GAAP, application of GAAP, an understanding of internal controls and an understanding of audit committee functions. There is no requirement to have education and experience as a certified financial planner.
Choice “c” is incorrect. The financial expert qualifies through education or past experience as an auditor or finance officer for an issuer of similar complexity. The expert should have an understanding of GAAP, application of GAAP, an understanding of internal controls and an understanding of audit committee functions. There is no requirement to have experience in tax return preparation.
Generally, an organization will not operate beyond the limits of their risk appetite. Risk appetite has generally been exceeded when:
a.
The likelihood and impact of positive events is within the residual risk.
b.
The likelihood and impact of negative events exceed residual risks.
c.
The likelihood and impact of positive events is significantly below residual risk.
d.
The likelihood and impact of negative events significantly exceeds residual risks.
Choice “d” is correct. Generally, an organization’s risk appetite has been exceeded when the combined likelihood and impact of negative events significantly exceed residual risk. Residual risk represents the risk that remains after management has taken actions to mitigate negative events. If the likelihood and impact of those negative events significantly exceeds the residual risk, the operation is likely to exceed the organization’s risk appetite.
Choice “b” is incorrect. An organization’s risk appetite may go beyond the risk that they control. When the likelihood and impact of negative events exceeds residual risk, management will need to carefully evaluate their actions, but they may not have exceeded their risk appetite.
Choice “a” is incorrect. Positive events represent opportunities. If those opportunities are within residual risk, then the opportunity will likely be pursued.
Choice “c” is incorrect. Positive events represent opportunities. If those opportunities are significantly below residual risk, then the opportunity will likely be pursued.
According to the Sarbanes-Oxley Act of 2002, which of the following statements is correct regarding an issuer’s audit committee financial expert?
a.
The audit committee financial expert must be the issuer’s audit committee chairperson to enhance internal control.
b.
The issuer must fill the role with an individual who has experience in the issuer’s industry.
c.
If an issuer does not have an audit committee financial expert, the issuer must disclose the reason why the role is not filled.
d.
The issuer’s current outside CPA firm’s audit partner must be the audit committee financial expert.
Choice “c” is correct. Sarbanes-Oxley Section 407 requires that an issuer’s audit committee have at least one financial expert, or disclose why that role is not filled. Section 407 requires that the financial expert have an understanding of GAAP and financial statements, be able to assess the application of accounting principles, have comparable experience applying accounting principles to entities that present a similar level of complexity of the issuer, and understand both internal controls and audit committee functions.
Choice “d” is incorrect. The audit committee is charged with negotiating the engagement of the external auditor and supervising their work. The auditor is accountable to the audit committee. The partner in charge of the audit firm engaged to do the audit should not be the financial expert on the audit committee.
Choice “b” is incorrect. Section 407 requires that the audit committee’s financial expert understand the application of accounting principles to the issues representative of the complexity of the issuer but does not require specific experience in the industry. Section 407 defines four ways in which the necessary attributes of a financial expert can be achieved: education, experience supervising a financial officer, experience overseeing auditors, or other relevant experience.
Choice “a” is incorrect. Section 407 does not require that the audit committee’s chairman be its financial expert.
A company that maintains a strong internal audit function that reports directly to the Board of Directors is applying the ideas from which principle of effective internal control over financial reporting?
a.
Organizational structure.
b.
Human resources.
c.
Board of Directors.
d.
Authority and responsibility.
Choice “a” is correct. The organizational structure principle says that reporting relationships should not undermine the commitment to effective financial reporting and internal control. Maintaining reporting independence of the internal auditor is one way to apply this principle.
Choice “c” is incorrect. The Board of Directors’ principle says that the board should be actively involved in overseeing the implementation of both financial reporting and internal controls. The principle relates more to leadership than to reporting relationships.
Choice “d” is incorrect. The authority and responsibility principle says that authority and responsibility should be delegated to individuals within the organizational structure as appropriate to maintain effective internal controls. The authority and responsibility of individuals can be undermined by flaws in the organizational structure.
Choice “b” is incorrect. The human resources principle says that human resources policies and procedures should be fully compatible with effective financial reporting and internal control. Competence, not reporting structures is emphasized by this principle.
According to COSO, which of the following is the most effective method to transmit a message of ethical behavior throughout an organization?
a.
Strengthening internal audit’s ability to deter and report improper behavior.
b.
Specifying the competence levels for every job in an organization and translating those levels to requisite knowledge and skills.
c.
Demonstrating appropriate behavior by example.
d.
Removing pressures to meet unrealistic targets, particularly for short-term results.
Choice “c” is correct. According to the COSO, demonstrating appropriate behavior by example is the most effective method to transmit a message of ethical behavior throughout an organization. The commitment to ethical behavior begins with the tone at the top, and is best established by management’s demonstrated commitment to ethical behavior.
Choice “a” is incorrect. Although detection of unethical behavior with improved internal audit resources is important, it is not as effective in transmitting a message of ethical behavior as leadership by example.
Choice “d” is incorrect. Realistic goals are an important component of a corporate culture that encourages ethical behavior; unrealistic goals may provide reasons for unethical behavior. But, according to COSO, they are no substitute for a strong commitment by management and an ethical tone at the top.
Choice “b” is incorrect. A competent work force supports ethical behavior and provides an environment where ethical behavior will thrive. However, a demonstrated commitment to ethical behavior by management is the most effective method for transmitting a message of ethical behavior throughout the organization.
The Sarbanes-Oxley Act of 2002 requires that the members of the audit committee be independent with regard to the issuer. Within the meaning of the law, which of the following corporate officers would be considered independent?
~Board Member
~Independent Auditor
a.
No
No
b.
Yes
No
c.
No
Yes
d.
Yes
Yes
Rule: Audit committee members are to be members of the issuer’s Board of Directors but also must be otherwise independent. Independence criteria are as follows:
Audit committee members may not accept compensation from the issuer for consulting or advisory services.
Audit committee members may not be an affiliated person of the issuer (affiliation means a person has the ability to influence financial decisions).
Choice “b” is correct. Board membership does not impair independence for purposes of audit committee membership (in fact, being a board member is a requirement). The independent auditor is hired and paid by the audit committee and thus is not independent, per the rule above.
Choices “d”, “c”, and “a” are incorrect, based on the above explanation.
The Hartman Conglomerate completed its annual retreat of board members and senior management and produced a document that links the organization’s mission and vision with strategic and related objectives. The document includes a commitment to develop a uniform chart of accounts for all divisions of the conglomerate. That commitment would most likely be a:
a.
Related compliance objective.
b.
Related operations objective.
c.
Strategic objective.
d.
Related reporting objective.
Choice “d” is correct. Establishment of a company-wide uniform chart of accounts would most likely be a related reporting objective. Uniform charts of accounts would promote more efficient reporting.
Choice “c” is incorrect. Strategic objectives are generally less operationally specific than the related objective contemplated by the uniform chart of accounts.
Choice “b” is incorrect. A uniform chart of accounts is a related reporting objective, not an operations objective.
Choice “a” is incorrect. A uniform chart of accounts is a related reporting objective, not a compliance objective.
Kamp Sporting Goods seeks to establish a code of conduct that will communicate the “tone at the top” to all employees. The contents of the code will likely include all of the following, except:
a.
Definitions of common sense approaches to software piracy to ensure that the company is competitive.
b.
Descriptions of the organization’s commitment to compliance and confidentiality.
c.
Prohibitions against conflicts of interest and self dealing.
d.
Prohibitions or limits on gifts and gratuities or establishes required reporting.
Choice “a” is correct. Codes of conduct likely will not condone exceptions to ethical behavior or the law in the name of competition.
Choice “c” is incorrect. Codes of conduct frequently include prohibitions against conflicts of interest.
Choice “d” is incorrect. Codes of conduct often include guidance on gifts and gratuities.
Choice “b” is incorrect. Codes of conduct will generally stipulate that information is privileged and should be kept confidential.
The business judgment rule is a rule that immunizes corporate:
a.
Management from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith and are within both the power of the corporation and the authority of management to make.
b.
Management from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith but are not within the power of the corporation or the authority of management to make.
c.
Shareholders from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith and are within both the power of the corporation and the authority of shareholders to make.
d.
Shareholders from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith but are not within the power of the corporation or the authority of shareholders to make.
Choice “a” is correct. Under the business judgment rule, a director is protected from liability for decisions made on behalf of the corporation if the director acts in good faith and in a manner that the director believes is in the best interest of the corporation, exercising the care that a reasonably prudent person would exercise in a similar position. The action must also ostensibly be within the power of the corporation to undertake and ostensibly within the authority of management to make.
Choice “b” is incorrect. A director will not be protected under the business judgment rule if he knowingly causes the corporation to undertake action that is not within the power of the corporation to take and not within the authority of management.
Choices “c” and “d” are incorrect. The business judgment rule protects directors; it is not applicable to the shareholders (except perhaps in the case of a closely-held corporation being run by the shareholders).
Able Corporation owns numerous businesses along the coast of Florida. The company’s management has identified business interruption events as a potential risk resulting from storm damages caused by hurricanes. The company elects to not only insure its properties but to “buy down” standard deductibles with additional premium. Able’s response to potential risks is known as:
a.
Reduction.
b.
Acceptance.
c.
Sharing.
d.
Avoidance.
Choice “c” is correct. Insuring against losses or entering into joint ventures to address risk is known as risk sharing.
Choice “d” is incorrect. A response to risk that involves the disposal of a business unit, product line or geographical segment is called risk avoidance. Obtaining appropriate insurance is not avoidance.
Choice “a” is incorrect. A response to risk that involves the diversification of product offerings rather than elimination of product offerings is called reduction. Obtaining appropriate insurance is not reduction, it is sharing (the risk has not changed; it has been shifted to another party).
Choice “b” is incorrect. Self insuring or simply tolerating the full exposure to risk is known as acceptance. Obtaining appropriate insurance is not acceptance of risk.
The Gotham Corporation regularly produces budget vs. actual data for its managers. The company is particularly sensitive to personnel costs, and division variances of greater than five percent for any period are promptly investigated to determine if budgeted postions have not been filled or if there has been extraordinary overtime. Timely exception resolution of this character illustrates the information and communication principles typically associated with:
a.
Obtain and Use Information.
b.
Internal Communication.
c.
External Communication.
d.
Financial Reporting Information.
Choice “a” is correct.The principle of obtain and use information is applied when the organization obtains or generates and uses relevant, high-quality information to support the functioning of the control. In this case, management is using the exception report (information) to support the control of monitoring overtime costs.
Choice “d” is incorrect. Financial reporting information is not a principle of COSO.
Choice “b” is incorrect. Internal communications anticipate that communications enable and support understanding and execution of internal control objectives, processes, and individual responsibilities. Variance analysis specifically supports internal control, not simply internal communications generally.
Choice “c” is incorrect. External communications anticipate that matters affecting the achievement of financial reporting are communicated with outside parties.
All of the following management activities of the Falco Insurance Group, Inc. are evidence of the ongoing monitoring of internal controls built into the company’s system, except:
a.
The CEO and CFO are required to formally verify that all major disbursements such as for claims and reinsurance premiums fully comply with the planned program of insurance.
b.
The CEO and CFO review monthly disaggregated gross margin and operating margin data by line of coverage.
c.
The CFO reviews changes in liability reserves in excess of a specified threshold.
d.
The CFO updates the audit committee on status of internal control.
Choice “d” is correct. Regular reporting to the audit committee represents reporting of deficiencies, not ongoing monitoring.
Choice “a” is incorrect. Ongoing monitoring of internal controls include such functions as verification that major disbursements meet the criteria for planned risk retention as part of a program of insurance. Formal authorization of all major disbursements such as for claims and reinsurance premiums for this purpose represent an ongoing monitoring.
Choice “c” is incorrect. Ongoing monitoring of internal controls include such functions as authorization of major disbursements, reviews of large or unusual transactions and high level reviews of disaggregated information. Reviews of changes in liability reserves in excess of a specified threshold represent ongoing monitoring.
Choice “b” is incorrect. Ongoing monitoring of internal controls include such functions as authorization of major disbursements, reviews of large or unusual transactions and high level reviews of disaggregated information. Monthly reviews of disaggregated gross margin and operating margin data by line of coverage represents ongoing monitoring.
The Sarbanes-Oxley Act of 2002 requires that the management report on internal control include all of the following, except:
a.
A conclusion about the effectiveness of the company’s internal controls.
b.
A statement that the auditor has attested and reported on management’s evaluation of internal controls.
c.
A statement that there are no disagreements between management and the auditor as to the effectiveness of internal controls.
d.
A statement of management’s responsibilities for establishing and maintaining adequate internal controls.
Choice “c” is correct. Financial statement disclosures include management’s assumption of responsibility for internal control, management’s assessment of internal control effectiveness and a statement that the auditor has reported on management’s evaluation. Management does not describe disagreements, if any, between management and the auditor.
Choices “d”, “a”, and “b” are incorrect, based on the above explanation
Extra Edge Sporting Goods has set a strategic objective of being in the upper quartile of sporting goods retailers. The company identified a related objective of increasing its sales force by 50 new staff members while maintaining staff cost at .194 cents per sales dollar. Events identified by the management of Extra Edge that might interfere with achievement of their related objective would include all of the following, except:
a.
Job markets may heat up and cause fewer offers to be accepted for the expanded sales force.
b.
Inadequate needs assessments may result in bad staffing decisions.
c.
Job markets may slow down and result in more staff accepting positions than there are available positions.
d.
Product demand may fall if sporting goods become less popular.
Choice “d” is correct. Although product demand is a legitimate concern, the related objective is associated with staffing levels. The drop in product demand would not be an event identified regarding the objective of hiring staff within certain cost constraints.
Choice “a” is incorrect. An overheated job market that creates a reduced pool of job applicants is an event that would affect Extra Edge’s objective of adding 50 new staff members.
Choice “b” is incorrect. Inadequate needs assessments is an event that could impact the quality of the new staff added by Extra Edge and would impact the objective of adding 50 new staff members.
Choice “c” is incorrect. A sluggish job market is an event that could not only result in an abundance of staff but could also produce acceptance of more offers than there are available positions and would impact Extra Edge’s objective of adding 50 new staff members.
In order to comply with a director’s duty of loyalty to a corporation, what action(s) should a director take when presented with a corporate opportunity?
a.
Accept the opportunity and not offer it to the corporation.
b.
Offer the opportunity to the corporation and accept it if the corporation rejects it.
c.
Accept the opportunity and disclose the acceptance to the corporation.
d.
Reject the opportunity and not offer it to the corporation.
Choice “b” is correct. The business law concept of “duty of loyalty” is a common ethical standard. The director’s duty of loyalty requires that the director offer opportunities presented in the market place first to the corporation and only accept them if the corporation rejects it. A land developer might sit on the board of a land development company. If presented with the opportunity to purchase a building or land at a significant discount, the developer would be obligated to offer the opportunity to the corporation first but would not be barred from taking advantage of the opportunity if the corporation had no interest.
Choice “d” is incorrect. The duty of loyalty does not require that a director ignore an opportunity by personally rejecting it and not offering it to the corporation.
Choice “a” is incorrect. A director’s duty of loyalty requires both disclosure and offering the opportunity to the director’s corporation before accepting the opportunity.
Choice “c” is incorrect. A director’s duty of loyalty requires both disclosure and offering the opportunity to the director’s corporation before accepting the opportunity.
Management has carefully evaluated the likelihood and impact of events on its foreign operations. In the event of a 3% variation in exchange rate, the impact is estimated at $10 million without any action taken by management and $4 million if the company purchases a hedge instrument. The impact of the inherent risk of changes in foreign currency exchange on achieving company’s business objectives is:
a.
$ 4 million.
b.
$ 6 million.
c.
$14 million.
d.
$10 million.
Choice “d” is correct. Inherent risk is the risk to an entity in the absence of any actions management might take to alter either the risk’s likelihood or impact. The $10 million exposure identified in the problem is the risk exposure without management’s intervention.
Choice “c” is incorrect. The inherent risk is not the sum of the inherent risk of $10 million and the residual risk of $4 million.
Choice “b” is incorrect. The inherent risk is not the difference between the inherent risk of $10 million and the residual risk of $4 million.
Choice “a” is incorrect. The $4 million risk exposure, after management purchases the hedge, is the residual risk. Residual risk is the risk that remains after management responds to the risk.
Able Corporation owns numerous businesses along the coast of Florida. The company’s management has identified business interruption events as a potential risk resulting from storm damages caused by hurricanes. The company elects to balance its portfolio of risk with property investments on the coast of other states and in Florida’s interior. Able’s response to potential risks is known as:
a.
Sharing.
b.
Avoidance.
c.
Acceptance.
d.
Reduction.
Choice “d” is correct. A response to risk that involves the diversification of product offerings rather than elimination of product offerings is called reduction.
Choice “b” is incorrect. A response to risk that involves the disposal of a business unit, product line or geographical segment is called risk avoidance. Adjustments to the portfolio do not represent avoidance.
Choice “a” is incorrect. Insuring against losses or entering into joint ventures to address risk is known as risk sharing. Adjustments to the portfolio do not represent sharing.
Choice “c” is incorrect. Self insuring or simply tolerating the full exposure to risk is known as acceptance. Adjustments to the portfolio do not represent acceptance.
The Carlton Corporation publishes an Employee Handbook that contains employee responsibilities for moral behavior including a code of conduct. Each year, employees must acknowledge their receipt of the handbook, their understanding of the code, and if they have any awareness of non-compliance within the company. The policies would indicate:
a.
Management and employees are assigned appropriate levels of authority and responsibility to facilitate effective internal control over financial reporting.
b.
Management’s philosophy and operating style support achieving effective internal control over financial reporting.
c.
Human resources practices are designed and implemented to facilitate effective internal control over financial reporting.
d.
Sound integrity and ethical values are developed and understood and set the standard of conduct for financial reporting.
Choice “d” is correct. The existence of a published code of ethics and a periodic acknowledgment that ethical values are understood is evidence of development of ethical values and ensuring that those values are understood and taken seriously.
Choice “c” is incorrect. Human resources standards generally relate to hiring practices and appropriate placement of individuals within the organization based on job descriptions, rather than the specifics of ethical behavior.
Choice “b” is incorrect. Management’s operating style relates more to work ethic and commitment to effective financial reporting than the specifics of ethical behavior.
Choice “a” is incorrect. Appropriate delegation relates to the organization’s assignment of duties rather than to the specifics of ethical behavior.
Which of the following is not a goal of an Enterprise Risk Management Framework (ERM)?
a.
Achieve financial and performance targets.
b.
Avoid adverse publicity and damage to the entity’s reputation.
c.
Provide reasonable assurance that company objectives and goals are achieved and problems and surprises are minimized.
d.
Assess risks continuously and identify the steps to take and resources to allocate to overcome or mitigate risk.
Choice “b” is correct. Avoiding adverse publicity and damage to the entity’s reputation is a public relations function, not a function of ERM.
Choice “c” is incorrect. ERM focuses on numerous goals including providing reasonable assurances that objectives and goals are achieved.
Choice “a” is incorrect. ERM focuses on numerous goals including achievement of financial and performance targets.
Choice “d” is incorrect. ERM focuses on numerous goals including risk assessment and mitigation.
According to COSO, an effective approach to monitoring internal control involves each of the following steps,except:
a.
Increasing the reliability of financial reporting and compliance with applicable laws and regulations.
b.
Designing and executing monitoring procedures that are prioritized based on risks to achieve organizational objectives.
c.
Establishing a foundation for monitoring.
d.
Assessing and reporting the results, including following up on corrective action where necessary.
Choice “a” is correct. Increasing the reliability of financial reporting and compliance with applicable laws and regulations is an approach to promoting a management philosophy and style that is congruent with effective financial reporting and control, not monitoring. Monitoring internal control may involve establishing a foundation for monitoring, prioritization of monitoring procedures based on risk to achieve organizational objectives, and assessing reporting results and following up as appropriate with corrective actions.
Choice “c” is incorrect. Embracing the attributes of the monitoring principle including establishing a foundation for monitoring is an effective approach to monitoring.
Choice “b” is incorrect. Designing procedures that are prioritized based on risks to achieving organization objectives is an effective approach to monitoring. Management might consider, for example, developing a list of control weaknesses that would seriously, rather than immaterially, threaten the reliability of financial reporting to establish standards for immediate reporting.
Choice “d” is incorrect. Assessing and reporting results, including following up on corrective actions, is an effective approach to monitoring. Management might consider, for example, establishing procedures that require reporting all deficiencies to a responsible manager.
